The secretive world of hedge funds disclosure has been exposed in a report published in the US, which reveals that up to half of funds and managements lied in their disclosure to customers and investors.
Hedge funds are part of what’s known as “The Shadow Banking System”, which exploited the credit boom, selling dodgy securities, buying the same securities, and helped bring the global economy and financial system to the edge of collapse late last year.
They were major factors in bringing us the biggest world credit crisis and recession since World War 2. And they did this without fully understanding their role in it or their responsibilities to the economy, their peers and especially their clients and customers. There was very little scrutiny of their actions, except what they decided to tell investors customers and the public via the media and fruity press releases.
It is part of the explanation as to why Bernie Madoff was allowed to flourish (poor regulatory oversight was another) and run his multibillion dollar Ponzi scheme and get away with it for so long.
But the report has revealed that 49%% of those involved in hedge funds have not been truthful in their disclosures to clients. This has included not being able to give accurate figures for returns, asset values, verification of performance problems (nearly 20%) and a similar number misstated the past legal and regulatory experience of the funds and the managers.
In other words, fiddling the records, poor management and knowledge were symptomatic, perhaps systemic with up to 49% of managers surveyed (out of 444) in confidential reports, involved in inadequate, incomplete disclosures and representations. Overall transparency was almost non-existent and yet these organisations controlled the flow of hundreds of billions of dollars of funds in every conceivable market.
The problems were disclosed in a joint survey of so-called due diligence reports done for investors in hedge funds. It involved researchers from several business schools and suggests this is widespread.
Using confidential information from 444 due diligence reports commissioned by investors between 2003-2008, the research teams looked at the extent to which hedge fund managers’ representations about their funds differed from reality. The due diligence reports were the only way investors and others could verify the accuracy of what they were being told by the hedge funds, their managements and promoters.
The paper identified “noted verification problems” — characterised as “misrepresentations or inconsistencies” — in 42% of due diligence reports.
In some instances the discrepancies represented managers’ unfamiliarity with their internal procedures and legal processes, but in 21% of cases “the manager verbally stated incorrect information”.
Covering funds with up to $US8 billion in assets under management and managers with an average of 19 years’ experience in the industry, the study captures some of the most prominent hedge funds in operation. The reports were provided on the basis that the names of the funds remained confidential.
It is the first detailed examination of disclosure by hedge funds.
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